Friday, January 25, 2013

Estimating Value: Part 2 Using Multiples

Following up on two previous posts, ( Value is Estimated, Price is Paid and Estimating Value: Part 1 DCF ) we begin a multiple post discussion of the use of multiples to estimate value.  We use multiples all the time in our daily lives.  As just a few examples consider driving:  miles per gallon, miles per hour, price per hour of parking.  Consider college: price per class,  price per credit hour, average price per book.  Consider housing: price per square foot (or meter), price per kilowatt hour (for heating).  Consider advertising: price per (internet) hit, price per name (for mailing lists), price per column inch (for print advertising).  Consumer products are standardized as price per unit (often an ounce, etc.)  And certainly our wages are expressed in multiples: salary per year, dollars per hour.

Multiples are pervasive.  So it should not be surprising that multiples are used in business valuation.  Note that in each example listed in the first paragraph, the multiple was expressed as a factor of a base (the item after per).  The base should be something meaningful to what we are estimating.  In business valuations, some common bases include: earnings, book value, EBITDA, sales, cash flow, growth, customers and other items.

In business valuations, we choose an appropriate multiple for our industry, find the relevant value for our company (by looking at the average or weighted average multiple of comparable companies), and apply the result to the appropriate base value for our company.

As an example, consider the price earnings ratio.  When we are buying a company (or a fraction of a company, i.e., a share of stock), we are essentially buying the future earnings stream of a company.  It makes sense to use earnings as a meaningful base from which to project price.  So let's say we estimate next years earnings for our firm to be $3. per share and we find a set of companies similar to ours with an average price earnings ratio of 10.  The implication is that our company is or will be worth $3 x 10 = $30. per share.

Similar calculations would be used for other bases (book value, sales, etc.)  In some cases one type of base is more meaningful for a particular industry.  In other cases, analysts might average several valuations resulting from various multiples or weight the valuations according to factors relevant in the particular situation.

A very partial list of some multiples used in practice include:

  • Price to earnings
  • Price to book value
  • Price to sales
  • Enterprise value (i.e., equity plus debt) to sales
  • Price to EBIDTA


Practitioners have also evolved elaborate variations on strict multiples. (Note: I'm not commenting on the merits of these multiples here or the superiority or lack of it in the multiples listed below.  I will, however, discuss advantages and disadvantages of multiples in general in my next post.)   Consider a list of industry multiples provided by Snowden (1994) and shown in Table 1 below.  The items being multiplied vary by industry.  Many also include specific adjustments for inventory or equipment.

Table 1:               Industry Multipliers

Travel agencies:
.05 to .1 X Annual Gross Sales
Advertising agencies:
.75 X Annual Gross Sales
Collection agencies:
.15 to .2 X Annual Collections + Equipment
Employment agencies:
.75 X Annual Gross Sales
Insurance agencies:
1 to 2 X Annual Renewal Commissions
Real estate agencies:
.2 to .3 X Annual Gross Commissions
Rental agencies:
.2 X Annual Net Profit + Inventory
Retail businesses:
.75 to 1.5 X Annual Net Profit + Inventory + Equipment
Sales businesses:
1 X Annual Net Profit
Fast food (nonfranchise):
.5 to .7 X Monthly Gross Sales + Inventory
.3 to .5 X Annual Gross Sales, or .4 X Monthly Gross Sales + Inventory
Office supply distributors:
.5 X Monthly Gross Sales + Inventory
.75 to 1.5 X Annual Gross Sales
.4 to .5 X Annual Net Profit + Inventory + Equipment
Food distributors:
1 to 1.5 X Annual Net Profit + Inventory + Equipment
Building supply retailers:
.25 to .75 Annual Net Profit + Inventory + Equipment
Job shops:
.5 X Annual Gross Sales + Inventory
1.5 to 2.5 X Annual Net Profit + Inventory or  .75 X Annual Net Profit + Equipment + Inventory (including work in progress)
Farm/heavy equipment dealers
.5 X Annual Net Profit + Inventory+ Equipment
Boat/camper dealers:
1 X Annual Net Profit + Inventory + Equipment
Professional practices:
1 to 5 X Annual Net Profit

Source: The Complete Guide to Buying a Business, Richard W. Snowden AMACON, New York, 1994, pp. 150-151.

These were given at a particular point in time and learned from actual experience.  As you will learn in our next post, they are unlikely to be relevant today, but you can see variation in multiples suggested with various adjustments for different industries.  

From all of this detail you might assume I am a huge fan of using multiples in valuation.  I am not.  Don't get me wrong, multiples are an important part of our valuation toolkit, but they have distinct advantages and disadvantages.  It is important to understand these attributes before using multiples.  We'll cover that topic in Monday's blog.

All the best,


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